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This article was first published in the April 2017 international edition of Accounting and Business magazine.

The International Public Sector Accounting Standards Board (IPSASB) was tasked with developing accounting requirements for the public sector that would more faithfully represent the nature of the transactions actually happening in that sector.

One area of specific guidance that was lacking in the IPSASB literature until this year was organisational restructures in the public sector. The private sector international accounting standards – International Financial Reporting Standards (IFRS) – upon which IPSAS are based (the relevant IFRS here is IFRS 3, Business Combinations), do not deal with the non-exchange nature of amalgamations in the public sector. The need for guidance has become more urgent in recent years as bailouts, nationalisations and restructures of government entities occurred in the wake of the global financial and sovereign debt crises. The highly anticipated IPSAS 40 was issued at the end of January this year.

Affected transactions

IPSAS 40 applies to combinations of assets and liabilities that constitute an operation. The standard defines an operation as an ‘integrated set of activities and related assets and/or liabilities that is capable of being conducted and managed for the purpose of achieving an entity’s objectives, by providing goods and/or services’. A public sector combination could occur by mutual agreement of the parties involved, or by compulsion (eg through legislation). Examples of public sector combinations include nationalisations and bailouts – where a non-exchange acquisition occurs without the transfer of consideration; centralisation of government functions; and reorganisation of government entities.

After ascertaining that a transaction falls within the scope of the standard, the next step is to assess whether the combination is an amalgamation or an acquisition. In situations where nil consideration is paid to the recipient of the transferred net assets, where there is no identifiable recipient of the transferred assets, or where consideration is paid not as compensation for the transferred net assets, according to the standard this would indicate that the combination is an amalgamation. Furthermore, if the combination is imposed by a third party without involvement from the parties to the combination, if the combination is subject to citizens’ approval through a referendum, or if a combination under common control occurs, these circumstances would also point towards the combination being classified as an amalgamation.

An acquisition would require an acquirer to be identified. In other words, one of the parties to the transaction would be deemed to have obtained control of any net assets/liabilities transferred. Usually, an acquisition requires the voluntary participation by the parties involved. However, in circumstances where, for example, a government may decide to nationalise a private sector entity through legislation, against the wishes of the entity’s shareholders, the economic substance of this combination would be deemed more akin to an acquisition, as one party is gaining control of another’s operations. 

The gaining of control of operations by a party to the combination is an essential element of an acquisition, but the standard also states that this ‘control’ criterion in itself is not sufficient to determine whether a combination is an acquisition; a consideration of the economic substance of the combination is crucial in the determination.

The differentiation between IPSAS 40 and IFRS 3 is in the classification of combinations. IFRS 3, Business Combinations considers all business combinations to be acquisitions, because ‘true mergers’ are very rare (virtually non-existent) in the private sector. However, in the public sector, mergers are common. In the public sector, there may be no quantifiable ownership interests in a public sector entity, which makes it impossible to identify an acquirer in such circumstances.

Two approaches

The classification of the combination is crucial as the recognition and measurement criteria for the transferred assets and liabilities are different under the modified pooling of interests approach used for amalgamations versus the acquisition method used for acquisitions.

Under the modified pooling of interests method, the identifiable assets and liabilities of the combining operations are measured at their carrying amounts in the financial statements of the combining operations at amalgamation date, apart from limited exceptions for licences or similar rights, income taxes and employee benefits. The modified pooling of interests method takes place at the date of an amalgamation, consequently no comparative information is required. An entity could voluntarily choose to present prior period information without any restatements, with explanation of the basis on which the information is presented.

Besides the cost/benefits reasons for supporting the modified pooling of interests approach, the IPSASB came to the view that the modified pooling of interests method is appropriate on the basis that users are able to assess the performance and accountability of the resulting entity, without the entity having to re-measure its assets and liabilities, and the amalgamation is portrayed as it actually is, ie a combination of assets and liabilities from the date of amalgamation. 

For acquisitions, largely consistent with the requirements in IFRS 3, Business Combinations, identifiable assets acquired and liabilities assumed are measured at their fair values at acquisition date. Goodwill or a gain from a bargain purchase is recognised for the excess between consideration transferred (plus the amount of any non-controlling interest and fair value of an acquirer’s previously held equity interest for step-acquisitions), and net amounts of the identifiable assets acquired and liabilities assumed.

Fair value concerns

During the consultation phase of the project, some respondents raised concerns on the difficulty of obtaining fair values of an item and suggested using an item’s previous carrying amount as a proxy for fair value under the acquisition method. The IPSASB did not agree and noted that using carrying amounts may not be appropriate in all instances. 

Therefore the exception to using fair values would only occur in rare circumstances and after an entity has made every reasonable effort to obtain the fair values of the assets acquired and liabilities assumed, but still failed to obtain them. As the accounting outcome of an amalgamation versus an acquisition is so different, classification of a combination would require significant judgment by preparers.

IPSAS 40 is effective from annual reporting periods beginning on or after 1 January 2019 and entities are allowed to early adopt the standard. The standard is applied prospectively only to combinations that occurred after the date of application.

Thomas Mueller-Marques Berger, EY global leader for international public sector accounting, and Serene Seah-Tan, director, financial accounting advisory services, Ernst & Young Australia

The views reflected in this article are the views of the authors and do not necessarily reflect the views of the global EY organisation or its member firms